UK Corporate Governance reform: changing the licence for companies to operate?

A summary and commentary on the Government's response to its Green Paper on corporate governance reforms which was published on 29 August 2017.

The Government published its final package of measures to tackle unwarranted executive pay deals and to improve corporate governance in its response to its Green Paper on corporate governance reforms1 on 29 August 2017. The Government has reiterated its approach of "strengthening corporate governance through non-legislative, code-based provisions and voluntary industry action to keep pace with higher expectations of business, and only legislating where necessary".

The Government’s response has been informed by the Business, Energy and Industrial Strategy (BEIS) Committee’s Report on corporate governance (published on 05 April 2017)2. However as most of the recommendations in that report relate to the UK Corporate Governance Code (Code), they will be addressed when the Financial Reporting Council (FRC) carries out its fundamental review of the Code later this year.

The Green Paper did not address diversity issues but the response summarises the steps that have been taken by the Government and others to date and responds to the BEIS Committee report’s recommendations. The response notes that the new Business Diversity and Inclusion Group will be meeting for the first time this autumn and will be focusing on issues such as increasing female representation in senior leadership roles, BME participation and progression.

Main proposals

The main proposals are:

  • a new public register that will in effect "name and shame" all listed companies3 that have encountered significant investor opposition - where at least 20% of shareholders have objected to executive pay packages
  • a requirement that all listed companies publish the pay ratios between chief executives and their average UK worker, along with a narrative putting the ratio in context and explaining any changes year to year
  • new measures to ensure employees’ voices are represented in boardrooms - premium listed companies will be able to choose whether to: (i) appoint a non-executive director to represent employees (which is seen as the most likely to be adopted); (ii) create a workers’ advisory council; or (iii) nominate a director from among the employees
  • a voluntary set of corporate governance principles that will apply to larger private companies.

Our view

It might at first sight seem as if these proposals are backtracking, watered down, low-key or lacking meaningful impact. True, they are largely non-legislative. But that very non-legislative approach has been a source of strength and flexibility for UK corporate governance. These proposals mainly rely on reporting, visibility, guidance and transparency to let the market and stakeholders decide what is acceptable conduct by companies. So, in a subtle but deliberate way they affect companies’ "licences to operate", their brand, their corporate reputation and the trust in which they are held by employees, customers and other stakeholders. This can be seen in the proposals for pay ratios, explanations of how directors have taken into account the statutory factors in fulfilling their duties, the Investment Association’s new "naughty register" of those listed companies whose pay policies have received 20% or more votes against, and other aspects of these proposals. And, most importantly, the proposals significantly extend high standards of governance to various large private companies. The continuing focus on diversity and inclusion is welcome, this too relying mainly on voluntary action and public pressure.

Overall, these proposals need to be read alongside corresponding aspects of the implementation of the EU Non-Financial Reporting Directive and the FRC’s proposals for the strategic report of "traded companies". Those aspects are highly significant and are well aligned with the theme of a corporate licence to operate, requiring disclosure of the impact of various matters on a company’s activities and taking the strategic report into disclosures about anti-corruption, human rights and diversity, as well as stakeholder relationships, supply chains and a company’s purpose.

At a future date it would be advantageous to streamline the different reporting and disclosure requirements. Currently, there is a mixture (that lacks overall logic) of different requirements applying to traded, quoted or listed companies and companies with a certain level of turnover (such as for modern slavery) or employees (such as for gender reporting).

So, overall these proposals are a bit British, a bit reliant on companies not wanting to be named in the Daily Mail, but not to be under-estimated, at all.

Executive pay

The Government’s proposals are:

Shareholder rights over executive pay - listed companies will be "named and shamed" if 20% or more of shareholders vote against executives’ remuneration. The Investment Association (IA) will be asked to maintain a public register of these companies and to keep a record of what those companies say they are doing to address shareholder concerns. This is much weaker than the original proposal to give shareholders additional binding votes on executives’ pay.

The FRC, as part of its review of the Code, will be invited to specify the steps that premium listed companies should take when 20% or more vote against executive remuneration. Suggestions of what the FRC might consider are: the company having to respond publicly to dissent; or having to verify that dissent "has been addressed by putting the existing or a revised remuneration policy to a shareholder vote at the next AGM"; and whether these rules should apply to all premium listed companies or only to FTSE 350 premium listed companies.

The Government hopes that the register will be another tool - executive pay data and remuneration rows are already in the public domain - by which shareholders can increase their influence when it comes to discussions around executive pay levels, as well as “holding shareholders’ feet to the fire” to show that they are responding to public concern about the issue.

Remuneration committee role - the Government will invite the FRC to consult on giving remuneration committees greater responsibility for demonstrating how pay and incentives align across the company and to explain to the workforce how decisions on executive pay reflect the company’s wider pay policy.

The Government will also ask the FRC to require that the remuneration committee chairmen have served for at least 12 months before being appointed unless there is a clear and valid explanation why this is not appropriate.

Pay ratio reporting - the Government will legislate to require quoted companies4  to report annually the ratio of CEO pay to the average pay of the UK workforce; along with a narrative explaining changes to the ratio from year to year and how the ratio relates to pay and conditions across the wider workforce.

LTIPs - the Government will legislate to require quoted companies to provide a clearer explanation of the range of potential outcomes from complex, share-based incentive schemes. It is not convinced that LTIPs need to be abolished but agrees that companies should consider adopting other remuneration structures that may be more appropriate to their business model or strategy.

Holding periods for share-based remuneration - the FRC will be invited to consult on increasing the minimum vesting and post-holding period from 3 to 5 years to encourage companies to focus on long-term outcomes when setting pay.

Use of share buybacks - as set out in the Conservative manifesto, the Government will shortly announce details of a review of share buybacks to ensure that they cannot be used artificially to hit performance targets and inflate executive pay. The review will also consider whether share buybacks are crowding out the allocation of surplus capital to productive investment.

The Government makes it clear that it will consider further action "unless there is evidence that companies are taking active and effective steps to respond to significant shareholder concerns about executive pay outcomes".

Strengthening the employee, customer and stakeholder voice

The Government’s proposals are:

Directors’ duties - it will legislate to require all companies of a significant size to explain how their directors comply with the requirements in section 172 Companies Act 2016 (CA 2006) to have regard to employee interests and to foster relationships with suppliers, customers and others. Significant size is likely to be determined by the number of employees with the possible threshold being 1,000 employees.

Greater employee board representation - it will invite the FRC to consult on a new principle and provision for the Code which operates on a "comply or explain" basis, meaning that companies will either have to introduce one of the three options or explain why they have chosen not to do so.

The principle will establish the importance of strengthening the voice of employees and other non-shareholder interests at board level as part of running a sustainable business.

The provision will require premium listed companies to adopt one of three alternatives for greater employee representation at board level:

  • appoint a designated non-executive director to represent employees
  • create a formal employee advisory council, or
  • nominate a director from the workforce.

The Government will also ask:

  • ICSA and the IA to complete their joint guidance on practical ways in which companies can engage with their employees and other stakeholders at board level, and
  • the G100 group to prepare new advice and guidance on the practical interpretation of the directors’ duties in section 172 CA 2006.

Corporate governance in large privately-held companies

The Government believes the corporate governance framework for large private companies needs to be strengthened and it will invite the FRC to work with the Institute of Directors, the CBI, the Institute for Family Business and the BVCA and others to develop a set of corporate governance principles. These will be voluntary so that companies can continue to use other industry-developed codes and guidance.

The Government will also legislate to require all companies of a significant size to disclose their corporate governance arrangements in the directors’ report and on their website, including whether they follow any formal code. There will be an exemption for companies which are already subject to an existing corporate governance requirement. Significant size for these purposes is likely to be companies (both private and public) with more than 2,000 employees.

FRC powers

The responses to the consultation raised questions about whether the FRC has the powers, resources and status to enable it to monitor and enforce corporate governance matters effectively. The Government will ask the FRC, the FCA and the Insolvency Service to conclude new (or revised) letters of understanding to ensure the most effective use of their existing powers to sanction directors and the integrity of corporate governance reporting. The Government will then consider whether further action is required.


The Government intends to lay the draft legislation before Parliament before March 2018. The intention is that the reforms would come into effect by June 2018 and apply to financial years beginning on or after that date.

The FRC is expected to consult on amendments to the UK Corporate Governance Code in the late autumn.

The work on developing voluntary corporate governance principles for large private companies is expected to start in the autumn.


1 See Government Green Paper published: the pace of corporate governance reform accelerates for more information

2 See May the FRC be with you - House of Commons BEIS Committee Report on Corporate Governance for more information

3 The term "listed companies" is not defined

4 The term "quoted companies" is not defined

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.